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George Mason University School of Law; Tilburg University - Tilburg Law and Economics Center (TILEC)

November 12, 2010

Abstract:

There is an abundant economic and legal literature on the interface between intellectual property and standardization. Following the footsteps of Mark Lemley and Carl Shapiro, the bulk of this literature (the “hold-up literature”) focuses on the risks of patent “hold-up” faced by firms implementing standards involving intellectual property rights (“IPRs”) by manufacturing standard-compliant products.

This “hold-up” conjecture is usually described as follows. Once a standard has been adopted and manufacturers or users of standard-compliant equipment have incurred significant technology-specific sunk costs, switching to an alternative technology becomes too onerous. The industry in question will have become “locked-in” to the standard. The bargaining power of the owner of essential IPR will have thus increased as a result of standardisation and he will be able to extract more favourable licensing terms after standardisation than would otherwise have been the case.

The patent hold-up conjecture is thus a claim that, due to the market power gained through standardization, essential patent holders are able to negotiate royalties in excess of their true economic contribution and are thus over-rewarded. Others, including the author of this paper, have, however, argued that the alleged risks of patent hold-up have been grossly exaggerated in this literature by ignoring the significant constraints faced by essential patent holders and the very limited set of circumstances in which hold-up can occur.

Another problem with the hold-up literature is that, while it exaggerates the risks incurred by standard implementers, it entirely ignores the risks faced by innovators active in standardized fields. As will be shown in this paper, holding patents on valuable technologies does not by any means guarantee the innovator that it will be able to recoup its sunk R&D investments as it faces significant, and increasingly growing, risks. First, innovators have no guarantee that, however valuable, their technology will be selected to be part of the relevant standard(s). Technology selection is competitive and will be increasingly so now that “costs” considerations are taken into consideration. Second, even if their technology is selected, innovators have to negotiate with standard implementers, which as will be seen below are seeking through various means, including the exercise of monopsony power, to reduce the royalty payments they make to innovators. Third, standard implementers and their supporters are pushing for reforms that would weaken the bargaining power of essential patent holders, notably by depriving them of the ability to seek injunctive relief or by reinterpreting the definition of the commitment they give to SSOs to grant licenses on “fair, reasonable and non-discriminatory” (FRAND) terms in a manner that is unfavourable to them. Finally, as illustrated by recent competition law cases, innovators also face growing regulatory risks as implementers may seek to use competition rules to force royalties and other licensing terms down on the ground they would be contrary to FRAND, exploitative under the terms of Article 102 of the Treaty on the Functioning of the European Union (TFEU), etc.

By exploring these risks, which may – as will be argued – may create “reverse patent hold-ups” (in that essential patent holders instead of being over-compensated will in fact be under-compensated by being forced to accept royalties that are lower than the value of the contribution of their technologies to a standard), this paper seeks to fill an important gap in the current standard-setting literature and give a more accurate perspective on the challenges facing innovators in standardized fields.

This paper comprises V parts. Part II provides some background on SSOs involving technologies protected by IPRs and the IPR policies they traditionally adopt. Part III describes the patent hold-up conjecture as developed by its supporters and shows that the risks it creates for standard implementers and users of standardized products are grossly exaggerated. Part IV shows that, in contrast to the claims made by patent holdup theorists, innovators active in standardized fields face significant risks of being under-compensated and thus could become the victims of reverse hold-ups. Part V offers a conclusion in which it is explained that the efforts made by standard implementers to constrain the abilities of essential patent holders to generate revenues will harm innovation and prevent efficient specialization by particularly affecting firms that have a licensing business model.